This week’s announcement by the Spanish Minister for Ecological Transition that Spain, Portugal and a “political deal” were reached with the European Commission to temporarily cap prices for natural gas and coke used in power plants might seem to be a solution to high energy prices. However, a deeper analysis shows that the opposite is true. It is likely to have unintended effects for consumers, renewables, and green hydrogen on Iberian peninsula – Luis Del Barrio Castro
The price cap of 50EUR/MWh is significantly lower than the market prices of between 80-90EUR/MWh. Subsidizing this measure would not be funded from the state budget as it has in other EU countries. Instead, the proposal suggests that a mechanism be created to evenly distribute the cost of this measure among all consumers.
In order to avoid cross-border distortions, the initial proposal proposed that a two-bidding market system replace the current one-bid market mechanism. This would decouple the Iberian market and the European market. According to the Spanish Minister, however, the market mechanism will not be altered during the twelve months that the measure is expected. France will therefore purchase electricity subsidised by Spanish and Portuguese consumers at a cost of EUR1-2bn. Additionally, consumers will likely pay EUR4-6bn in the next 12 month. There are also at least three major disadvantages.
PPAs, or Power Purchase Agreements, have been identified by many as the foundation for the rapid growth of the renewable energy sector over the next years. In return for a long-term agreement with the developer, these contracts offer price stability and supply certainty. PPAs are a great way to attract customers and invest in green energy.
Customers would be discouraged from signing PPAs if the government proposed a premium. The premium price would also fluctuate hourly, making costs significantly higher. A lack of attractive PPAs could hinder the development of renewable energy projects. This is particularly evident when you look at hydrogen recovery funding. These funds are not available in Spain unless the owners of electrolyzers (the system that makes hydrogen gas from water by breaking it into hydrogen and oxygen through electricity) have either developed a renewable plant or signed a PPA to guarantee 100% green energy consumption. The increase in volatility and the increasing prices of PPAs could mean that the 210MEUR of European funds for hydrogen are at risk, along with 1BEUR of private investment.
Customers with market-indexed contracts will pay less for electricity at variable prices, but fixed price customers will be charged more. In reality, risk-averse customers will end up subscribing to risk-prone customers at EUR30/MWh to EUR45/MWh. This would create a rent transfer program in the Spanish electricity market. This is counterintuitive as most risk-averse customers would pay a premium to ensure they paid the price in the future.
Similar effects would be felt by industrial companies as a result of the proposed measure. Fixed price contracts companies will see their bills rise dramatically (sometimes even double), which could lead to operational risks. The market will make it more competitive for companies, and they will be more competitive than European counterparts. This will raise concerns about fair competition.
There are potential negative consequences for the energy transition as well as emissions reduction targets. Demand is expected to rise by 2-4GWh. This will lead to an increase in electricity consumption. Natural gas would be used to fuel the increased demand and produce more than 800 tons CO2 per hour. Hydro power plants could lose access to the market as they are likely to be replaced by subsidized power stations. Thus, natural gas generation would replace clean energy, increasing emissions. This could have an indirect effect on natural gas prices as a result of the increased consumption. This unexpected result will occur at a time when natural gases are a critical resource and there is already concern about scarcity.
This is not the deal that it seems to be. Fixed price customers will see an increase in their energy bills and the pace of the energy transition will suffer as no PPAs are signed in this year. Delaying the development and deployment of renewables projects could mean Spain loses the European funds for hydrogen deployment. This would have a negative impact on the long-term prospects of Spain and the region.
Luis Del Barrio Castro, Principal and Energy Practice Lead in Madrid office Arthur D. Little is an international management consulting firm.
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